Now that the financial crisis has become a political issue, there has been a surge of commentary on the financial markets from political commentators. Let's just say that they haven't raised the quality of the discourse. The sooner they're back to fighting about the outrage-du-jour on the campaign trail, the better, as far as I'm concerned.
One argument that has predictably caught on with the far right is the that the Community Reinvestment Act (CRA) caused the housing bubble. The CRA "forced" banks to make loans to minorities who were poor credit risks, the argument goes, and these "subprime loans" are the root cause of the financial crisis.
This argument is, of course, not true at all. A Bank for International Settlements working paper released this week concluded:

Contrary to some media commentary, there is no evidence that the Community Reinvestment Act was responsible for encouraging the subprime lending boom and subsequent housing bust. This Act only applies to depositories, and did not cover most of the important subprime lenders. Depositories showed a lesser tendency to write subprime loans than lenders not subject to the Act (Yellen 2008).

Arguing that the CRA caused the housing bubble reveals a lot about the person making the argument, but very little about the origins of the housing bubble.

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comments:

Anonymous
said...

You are either ideologically blinded or foolish if you can not see the connection between the CRA and the spread of loosened lending standards throughout the market. The market for home loans is like any other in that it is subject to competitive pressures. This includes competition in lending standards. When the CRA and pressure from the democrats in congress FORCED lower lending standards upon depositary institutions it was inevitable that these lower standards would spread to other sectors of the market even without any enforcement mechanism that existed with the banks and GSE's. Additionally the left wing activists prevailed upon congress to force the GSE's to lower their standards in purchasing and securitizing these loans. This the initial bad effects of the CRA spread throughout the financial system to the disastrous result we see today.

There is no evidence whatsoever to support your claim that the CRA caused the housing bubble. By contrast, there is substantial evidence that the CRA had nothing to do with the housing bubble, including the working paper I cited from the highly-respected BIS which explicitly rejected your claim. And you think I'm ideologically blinded?

Oh, the irony, it burns.

I've also represented depositories that were subject to the CRA, and have worked with their CRA compliance departments. Believe me, the CRA doesn't "force" depositories to do much of anything.

Sorry buddy, but if you think -- in spite of all the evidence -- that the CRA caused the housing bubble, then you simply don't know what you're talking about, at all, on any level.

http://en.wikipedia.org/wiki/Community_Reinvestment_ActWiki said: The Community Reinvestment Act is a United States federal law that requires banks and savings and loan associations to offer credit throughout their entire market area and prohibits them from targeting only wealthier neighborhoods with their services, a practice known as "redlining." The purpose of the CRA is to provide credit, including home ownership opportunities to under-served populations and commercial loans to small businesses. It has been subjected to important regulatory revisions.

From what I can understand, the fact that it tries to prevent "redlining" means that people who would not be able to get loans be given the opportunity to get a loan. While 100,000 people may not matter much but Clinton's goal of having 10 million new homeowner... something must give. I recall that the 10 million new owners are not to mean people who could afford a home already either.

Isn't...sorry, can't think of the verb...cow-towing to authority...a groveling obsequiousness to authority...one of the logical fallacies I was taught when I was but a wee tyke? I think it was...

The BIS is "highly respected"...I quote, from memory, from the 1938 Encyclopedia Britannica...."Hitler is a vegetarian known to love children. Bit of an issue with the Jews." Total paraphrasing, but you get the idea.. Lots of things/people are/were highly respected - Hitler, Encyclopedia Britannica...Doesn’t mean they’re right....or don’t change their minds in the face of further evidence...

Anyway, saying the CRA had NOTHING to do with it is like saying television violence has nothing to do with real violence. Of COURSE it does - no one needs a study to prove it...nor could a sociological study ever prove anything in a complex, real-world society, anymore than an economics study could ever prove anything without several parallel universes to act as the control universes, with their control earths....I mean, a butterfly’s wing could be argued to affect the economic situation, some...the question is how much...

It seems clear, to a disinterested party, that the government encouraged, in various ways, these sorts of loans...which helped raise housing prices, which made buying houses a more attractive option for renters, investors, etc. I think that’s indisputable....

Let me get this straight. Citing work from a highly-respected institution while also correctly noting that the institution is "highly-respected," is "cow-towing to authority...a groveling obsequiousness to authority"? That's an air-tight argument you've got there, chief.

Sure, it's technically impossible to know whether the CRA had literally nothing to do with the housing bubble, but you know what I meant. Any effect that the CRA had on the housing bubble was so minute as to be negligible from a practical standpoint.

The GSEs were squeezed out of the mortgage market in early 2004, because of the political, regulatory, and economic environment, which then led to an increase in private and massive unregulated capital into the mortgage market.

The resulting reshuffling of supply of mortgage capital in the market resulted in both a record increase in total lending volume after 2003 of alternative private instruments. The period between 2004-06 saw a substantial substitution of conventional conforming GSE loans for new private-and poorly underwritten instruments such as ABS products, alt-A, and private label subprime.

Combine the above with the originate-to-distribute model of complex instruments (securitization), investment banks playing carry trade (mismatched funding durations) with their balance sheets, relying on short term funding from money-market funds, and inadequate risk management models the most prominent being VAR and you get a disaster.

Remember housing defaults started to rise in early 2005, but the tipping point came in early 2007 when a small number of investment funds (Bear Stearns) chose to freeze redemptions, citing an inability to value their structured products backed by US subprime mortgages of recent vintage (2005-2006).Collateralized-debt obligations (CDOs) linked to such loans fell amid rising late payments by borrowers with poor credit or heavy debt. Credit spreads on such products then began to widen, rating downgrades increased, and the process accelerated sharply in August 2007. From this small beginning, the initial disruption then fanned out to virtually every corner of the global financial system.

The point is that existence of GSE i.e CRA subprime loan products with a pre 2004 vintages alone does not merit primary blame for the problems currently being experienced in the housing and mortgage markets.

Also, the mortgage problem was a 20 year bomb waiting to happen and involved politicians on both sides of the isles and dozens of firms with really greedy people.

The Way Forward.

The way out of the crisis will not be wealth created through housing, due to the fact that consumption has been an extraordinary share GDP funded with home loans and consumer debt, therefore it is highly likely that the next recovery will be driven from exports or capital goods spending (for exports). We need policies that stimulate capital investment and capital formation. We have to think about priorities. In the United States capital is not productive. As Paul Volker, former Chairman or the Federal Reserve recently stated on Charlie Rose, we have too many financial engineers and not enough electrical engineers. New technologies, alternative energy, skills and education investment are the ways forward.

In closing folks, ad hominem attacks are not a productive use of time, let’s endeavor to work together for the common good, our children’s futures demand it.

Interestingly enough the working paper you cite in defense of your argument that the CRA didn't cause the housing bubbles concludes with statements that seem to contradict this very argument:

"The recent distress in US mortgage markets has demonstrated the potential negative consequences of a temporary easing in lending standards. The underlying lessons from this are that institutional differences shape the response to global

"The recent distress in US mortgage markets has demonstrated the potential negative consequences of a temporary easing in lending standards. The underlying lessons from this are that institutional differences shape the response to global fi

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About Me

I'm a finance lawyer in New York. I used to focus on derivatives and structured finance (you know, back when there was a structured finance market). I spent the majority of my career at one of the major investment banks. My background is in economics and, unfortunately, politics.

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